Conclusions and policy recommendations: Privatisation paradigm

Privatisation should not be pursued as an ideology, as in modern economic theory and policy there is no room for dogmatism. After the Great Recession of 2008, the neo-liberal school of economics has been discredited and there is universal recognition for regulation of financial services.

The shining stars of economic performance – China in Asia, Germany in Europe, and Brazil in Latin America – have achieved their stellar growth without adopting privatisation as a major plank of public policy. There should be no privatisation for the sake of privatisation as has occurred in Pakistan. The role of public and private sectors should be delineated on a pragmatic basis without ideological fervour. Transparency in the process of privatisation is the indispensable condition for its success.

The ingredients of transparency are:

1. Proper advertisement

2. Proper determination of reserve price

3. Proper pre-qualification of bidders

4. Payment in short period of one to three years

Article 23 of Privatisation Ordinance of 2000 states, “advertisement for privatisation where necessary will also be placed in newspapers with international circulation”. Advertisements were placed in national newspapers but never), in newspapers of international circulations. In case of major privatisations like Habib Bank the foreign newspapers chosen were Arab News and Khaleej Times, whereas the relevant newspapers of international circulations are the Financial Times and the Wall Street Journal.

Financial consultants were appointed for determination of reserve price. It would take another study with full access to the records of the Privatisation Commission to determine if the reserve price was properly calculated in about hundred privatizations since 1990. The determination of reserve price should be done in a more elaborate manner as discounted cash flow is not always the best method. The resort to determining the assets value or the value based on the market price of shares should be preferred. In any case, a single method should not be adopted for value determination. Moreover, instead of appointing one evaluator for the sale of mega enterprises like Habib Bank and PTCL worth billions of rupees, it is necessary to appoint two to three evaluators and then hold a joint meeting with them to determine the correct value of the units to be privatised. Secrecy of reserve price was not maintained and in most cases bidders knew the reserve price. This was also observed in the study by the Asian Development Bank.

Pre-qualification of bidders requires consultation with its bankers, statement of taxes, market reputation and experience of running similar units. This was not rigorously done in many cases. The extreme example is of Schon group which was given two units all of which dosed after privatisation. Twelve other units closed after privatisation clearly indicating that buyers were assets strippers and had no intention of running them.

In many cases of privatisation especially those in 1990s, the bidders did not pay the amount in stipulated time period and recoveries despite bank guarantees were made after almost two decades. In short, privatisation in Pakistan suffers from lack of transparency. It would be idealistic to expect transparency in privatisation when Pakistan’s score in this field is only 0.3 out 1.0 according to the Transparency International.

The second essential condition of successful privatisation is proper sequencing. The word sequencing does not appear in any publication of the Privatisation Commission and it was never a consideration in the privatisation process in Pakistan. It is difficult to find good buyers if a large number of units, eg, 47 in 1992, were sold in a short period of one year. There should be alternation between big and small units, and the privatisation process should be spread over a long period of time to elicit a good response from private parties. The experience of international privatisation shows that rushed and bunched privatizations are hazardous.

The third condition for successful privatisation is sector selectivity. It is not the business of government to run small units like roti plants, flour mills, ginning factories, or rice huskers. Similarly, consumer goods products like vegetable ghee, soap, and other such goods should be left to the private sector. There can be a debate on keeping some factories in sugar, cement, and fertiliser in the public sector in order to prevent their cartelization, but on balance they should be in the private sector.

Pakistan is an energy deficient economy. We are producing only 20% of our oil requirements and facing acute short falls in electricity and gas. Although we have one of the largest reserve of coal of the world but we are net importers of coal. Sale of profitable energy units like Kot Addu Power Plant, oil and gas wells, National Refinery, LPG business of SNGL and SSGL etc, were not in national interest. Firstly there were a sizeable and stable source of government revenues and provided for government participation in the relevant boards to protect national interests. Secondly these were all bought by foreign companies as domestic entrepreneurs could not run them. Foreign investment in the energy sector should be encouraged to find more oil and gas rather than buying proven and highly profitable energy units. In the USA which is the citadel of capitalism, Unocal an oil company which produces only 1% of USA domestic output (which is half of its requirements) was being bought by a Chinese company. It raised such a hue and cry in the media and the Congress that the Chinese company was force to withdraw its offer. In almost all developing countries even as small as Kuwait and Qatar foreign participation is not allowed in their energy business.

Privatisation of Pakistan State Oil was being considered but it was shot down by the defence establishment as it is essential to have a national oil distribution company after the bitter experience of 1965 when all the distribution companies were foreign and they did not fully cooperate in the war effort. Therefore, the energy units should be treated as strategic assets whose sale to foreigners is not in national interests.

Public utilities/natural monopolies should also be excluded form the privatisation process. Firstly, in a monopolistic situation, the producer can raise prices without relation to cost and exploit the consumers. Secondly, public utility like PTCL should cover all areas and extend facilities to remote corners which are not profitable. There can be cross subsidisation in case of public management but a private party has no incentive to extend facilities to non profitable areas. Thirdly with foreign management PTCL could provide access to foreign intelligence on secret telephonic exchanges between Pakistan and foreign countries. Therefore some of the public utilities are strategic and should remain under national management.

The fourth condition for effective privatisation puts emphasis on the need to create favourable conditions for privatisation to succeed. The government must create better regulatory and institutional framework. In Pakistan, we have created Ogra for regulating gas and oil prices, Nepra for regulating electricity prices, and Competition Commission of Pakistan for conducting inquires and imposing punishments in case of cartelization and absence of competition. The regulatory framework must be put in place before starting with privatisation in vital economic sectors.

Privatisation follows the political framework and economic philosophy of its period. With the collapse of Communism in the USSR and the fall of the Berlin Wall in 1989, privatisation became an international norm. The neo-liberal school in economics and the Washington Consensus trilogy of liberalisation, deregulation and privatisation became the hallmarks of economic policy around the globe. The recent international breakdown shows that Western Europe accounted for almost half the revenues in the quarter century from 1977 to 2001, Asia with one-quarter, and the remaining in Latin America and other countries. In Western Europe, the UK was the leader, accounting for one-fifth of the transactions and revenues. The British privatisation through sale of shares to the public, which gained from capital appreciation, was the most successful international experience of privatizations. The experience of privatisation in others countries was ambivalent.

Privatisation leads to a fall in fresh additional investment, as it will crowd out investment in green field ventures. By diverting private capital from new productive investments with the latest technology into buying public sector units, economic growth could be retarded rather than accelerated. Therefore, privatisation prevents fresh investments with a concomitant negative impact on fresh employment, output, and economic growth.

Purchase of privatised units by foreign parties in not direct foreign investment but only foreign purchase. There is single shot injection of foreign exchange, but permanent remittance of profits. Foreign parties rarely buy with pay out period of more than four years.

The impact of privatisation on employment is also negative. Public sector units, especially in developing countries, are over-manned. The new private owner cuts down the labour force drastically. In the case of privatisations in 1990s, about one-fifth of the labour force in privatised units opted for the Golden Handshake as their security of employment after sale was guaranteed only for one year. In the case of PTCL, the labour force has been reduced by a half, from 64,000 to 32,000. As many units closed after privatisation in 1990s, their entire labour lost their jobs. Therefore, privatisation adds to the pool of jobless workers.

Privatisation has a positive fiscal impact, especially in case of units running at a loss, which however are not likely to be picked up by the private sector. The public revenues increase either from the sale of units or from the sale of shard of public sector units. But it is not a sustained increase; rather single injection into public purse. It could have a negative fiscal impact because the SOBs pay their taxes honestly as they have no incentive to evade taxes as both taxes and profits accrue to the government. The experience of many developing countries, where tax evasion is the norm, shows that taxes decrease after privatisation. Moreover, in the medium term, the public sector would lose income from profitable SOBs and would be stuck with unprofitable ones, which could also prevent cross-subsidisation that is inherent in the public sector as the poor are subsidised at the cost of more affluent sections of the society.

The compelling case for privatisation is improvement in the efficiency of units under private management. Theoretically, it all depends on principal agents. In developing countries, private sector CEOs selected on the basis of family links may not be better than the CEOs chosen by the government. In Pakistan, the CEOs of big public sector units are chosen without regard to their suitability, eg, sometime ago a convicted officer was appointed as the CEO of Oil and Gas Development Corporation of Pakistan, which is a huge organisation and significant national producer of oil and gas in the country. In India, there is a high-powered commission which presents a panel of three names to the Prime Minister, who has to choose one out of the three, and the Prime Minister cannot nominate a person outside the list presented to him. There is no such system in Pakistan and political cronyism is the major consideration. In the 1980s civil servants were often appointed as CEOs of public sector units. This author was appointed as the CEO of the Ghee Corporation of Pakistan (GCP) in 1987. With the able assistance from Ahsan Iqbal, who had just returned from Wharton, the GCP was turned around from loss to significant profits within a year. The GCP had 28 ghee mills scattered from Karachi to Nowshera. We could advertise on the only TV channel of PTV whereas the small competitors could not afford TV advertisement. Economies of scale were fully exploited to promote sales and profits.

Surprisingly, Z. A. Bhutto did not nationalise the textile mills and the sugar mills. The non-nationalisation of textile mills was well-conceived as textiles constitute about two-thirds of Pakistan exports and the private sector is more adept in exploring foreign markets. The sugar mills were not nationalised whereas the units smaller than them like rice-huskers were nationalised. Sugar mills then, as now, are mostly owned by politicians who are members of the provincial or national assembly. Their cartel could not be broken by the military government of General Musharraf or the democratic government of Zardari and Gilani. If there were five or ten sugar mills in the public sector, the cartel could easily have been broken and the consumers across the country would have obtained sugar at much cheaper prices.

The units which closed down after privatisation were mostly in the engineering and chemical sector. The weight of these two sectors in Pakistan’s total industrial production is very small. These are difficult units to operate when the scale is small. It was wrong to nationalise these, and it was doubly wrong to privatise them into inexperienced hands. The nationalisation and subsequent privatisation was a serious jolt to this complex sector.

It was again inadvisable to sell all the fertilisers factories. Firstly fertiliser factories are given gas at a subsidised rate and, secondly, Urea is an essential input for agriculture. The government can maintain a reasonable ratio between the prices of urea and main agriculture outputs like wheat, rice, cotton, and sugarcane. Moreover, selling the biggest fertiliser factory to Fauji Foundation was not privatisation in the true sense.

The privatisation of banks was well-conceived and all the privatised banks are performing better than before. In the Pakistani milieu, banks should not be in the public sector as risky loans are given to parties without securities, at political bidding. The latest scandal of Bank of Punjab, which gave a loan of Rs 9 billion to Harris Steel without sufficient securities, shows that no bank should be in the public sector. The Government of Punjab had to inject Rs 9 billion into the equity of the Bank of Punjab to keep it afloat. With the intervention of the Supreme Court, only a part of the loan has been recovered.

However, the banks were sold at very cheap prices, eg, Habib Bank was sold for Rs 22.4 billion when its price on the basis of shares sold to the public should have been Rs 83 billion. Moreover, the banks were sold to inexperienced foreign parties which did not have the know-how of running big commercial banks.

Public utilities and natural monopolies like the PTCL and KESC should never have been privatised as they cater to rich and poor users, and very often the poor are subsidised at the cost of the rich. Moreover, the monopolist, as stated in economic theory, can raise prices without relation to costs and squeeze the consumers with a detrimental impact on public welfare and economic growth. The sale of these strategic assets to foreigners is unadvisable on all counts.

The sale of UBL, Habib Bank, PTCL, and oil and gas wells to foreigners had brought foreign exchange at the time of sale but it has resulted in recurring financial outflow of profits by their foreign buyers. The remittance of investment income which was $2.1 billion in 1999-2000 surged to $5.5 billion in 2007-2008. This was primarily due to remittance of profits by privatised firms.

The best mode of privatisation internationally as well as in Pakistan is the sale of shares of public sector units in small lots and with the condition of maximum purchase by individuals. This was the mode of privatisation in the UK, which is considered to be the most successful privatisation in Western Europe.

The privatisation strategy of the current government has been devised in a hurry, without gaining from the experience of the past and the current economic situation in which Pakistan has very low credit rating. Initially, the government wanted to sell the Qadirpur gas field, but there was strong opposition from the OGDC workers and staff, forcing the government to withdraw its privatisation decision.

The government should gradually offload more of its shares through the stock exchange to the general public. The scheme of giving 10 percent shares in public enterprises free to the workers should be altered by charging some price for the shares sold. Many public enterprises are not incorporated, their shares are not listed on the stock exchange, and they are also running at a loss. Hence, the scheme is not very practical. For example, employees in the Railways and the Post Office will get nothing, whereas those in the OGDC and the PSO will get a substantial package.

The government has identified for privatisation a large number of public enterprises, including the Post Office and the Railways, although no private entrepreneur will be able to run such vast organisations. The suggested mode of privatisation is public-private partnership with the sale of 26 percent equity with management to private parties. This form of privatisation has not been practised in many countries and the experience of PTCL’s privatisation in Pakistan has not been very happy.

The list of privatisation drawn by the present government also includes enterprises like the Utility Stores Corporation, which provides essential goods to poor people at subsidised prices. The list needs to be revised carefully and only those, units may be privatised for which it can get a good price and competent buyers who can run these units in an efficient manner. The present government should not try to fill its quota of leftover units by privatising them to buyers who will run them more inefficiently, like the KESC, and retard economic growth and social progress in the country.

The present government should be very cautious about privatisation keeping in view the experience of the past and in other countries. The present security situation and massive load shedding should in fact bar fresh privatisation for a few years.

Thus the present government has done well by privatising on one unit in more than three years despite its ambitious privatisation strategy.

The main argument in favour of privatisation is inefficiency in bureaucratic management. There are many institutions like Railways which run very well in India and other countries but very poorly in Pakistan. The same is true of power generation transmission and distribution. Obviously Mangla and Tarbela dams cannot be privatised but they should be operated excellently. Privatisation is not a panacea for overcoming inefficiencies in all public sector units. Privatisation of KESC has not solved the problem of electricity in the commercial and industrial hub of Pakistan. In fact, it has aggravated the situation.

Management of public sector units can be improved immensely by appointing competent CEOs and board of directors. The appointment of public sector CEOs should be institutionalised as in India. Scandalous CEOs of NICL, Bank of Punjab and others have resulted in gigantic corruption and inefficiency.

If the argument of public sector inefficiency is taken to the absurd extreme police and courts should also be privatised but this cannot happen. They must operate efficiently and honestly.

There is no substitute for better governance whether in collecting taxes, providing electricity, running railways, efficient police, social services and natural monopolies. All industrial units and banks should be in the private sector but natural monopolies/public utilities – PTCL and KESC, as well as energy units like the oil and gas fields, Kot Addu Power, National Refinery, and LPG should have remained in public domain. Selling these units to foreigners especially Gulf parties was total negation of the national interests.

Privatisation is not the driving force in the outstanding economic performance of China, Germany, Brazil, Korea and more recently India and Turkey. Even in case of Pakistan, the average GDP growth in the last two decades of massive privatisation was 4.7 percent as compared to 6.7 percent in 1960s and 1980s when there was insignificant privatisation. Rushed privatisation in case of Russia led to decline in longevity by half a decade and shrinking of GDP by more than a third.

In last two years the government has been paying massive subsidies to the tune of more than Rs 300 billion to Pepco, PIA, Railways, Steel Mill and others. There has been a clamour for privatisation of these units by eminent economists and others without proper consideration of all the factors involved. Pepco is selling electricity at Rs 7 per unit whereas its cost is Rs 10. No party will buy Railways and PIA. Steel Mill should be privatised in transparent manner as almost all industrial units must be in private sector. Removal of differential between cost and selling price in case of Pepco and better management of Railways, PIA and others can significantly reduce the heavy burden of subsidies.

The organisation whose inefficiency, exclusions (agriculture etc) and corruption is costing the economy about Rs 700 billion is the Federal Board of Revenue. It cannot be privatised but its efficiency, coverage and integrity need a quantum jump. It supports the assertion that privatisation is not the panacea for all the ailing public sector organisations.

There is a famous couplet by Alexander Pope:

For forms of government, let fools contest Whatever is administered best is best This couplet can be changed for the topic under study For best role of government let ideologues contest Whatever leads to highest GDP growth, is best The principal policy recommendation of this study is that everything should be privatised with proper procedures and complete transparency to experienced and reputable parties except public utilities/natural monopolies and energy units.

The eternal adverse impact on balance of payments stemming from the sale of big units like HBL and UBL should have prevented their sale to foreigners. The government should give all incentives to foreigners for drilling more oil/gas wells and setting up pipelines and refineries but the sale of state-owned energy units to foreigners is stark denial of national interests. The best form of privatisation internationally is through the sale of shares to the general public. Privatisation should not be pursued as problematic philosophy but as pragmatic and purposeful public policy.

(The above was an excerpt from “The Impact of Privatisation in Pakistan” authored by Dr Akhtar Hasan Khan, former Secretary Planning. The newspaper is carrying it with an explicit permission of the author.)